ôActivist hedge funds are becoming increasingly visible in Asia where they are starting to compete aggressively with some of the regionÆs traditional investors,ö says Young Joon Kim, partner in law firm Milbank, Tweed, Hadley & McCloy.
The increase in activism is in part attributable to the large number of hedge funds now operating in the region. Traditionally, hedge funds focused on arbitrage. But this market is shrinking. Further, compelling opportunities to acquire stakes in under-performing companies are presenting themselves.
MilbankÆs Kim adds: ôAt the end of the day, labels donÆt matter as much as the return. Whether a fund is called a hedge fund or a private equity fund, the ultimate goal of any investment vehicle is the pursuit of the highest return possible. With the so-called easy money having already been made in the traditional distressed assets world, hedge funds are now having to look for other hitherto untried ways of extracting value out of investments.ö
Witness the rise of shareholder activism in Japan. It would have been unimaginable in the past that shareholders would confront management, both culturally and because until recently many publicly quoted companies were held through cross-holdings, creating a shareholder base friendly to management. The cross holdings are now down to around 20% and financial investors are holding larger stakes.
ôIn Japan, the unwinding of cross-holdings has increased the voting power of institutional investors and that diffusion of ownership naturally facilitates investor activism,ö says David Webb, Hong Kong-based former banker turned full-time editor of Webb-site.com, a non-profit corporate and economic governance site.
The wave of activism is spearheaded by institutions but, given the importance of retail investors in Japan, it needs to be backed by small investors to succeed. In February, shareholders of Japanese steel firm Tokyo Kotetsu voted down a takeover by Osaka Steel, thwarting a deal both companyÆs boards initiated. Institutional investor, Ichigo Asset Management who held a 12.6% stake in Tokyo Kotetsu, led the vote to reject the merger. Alone Ichigo could not have accomplished much as another 21% had to back Ichigo to achieve the requisite one third voting against. Ultimately 42% of shareholders voted not to support the merger, marking the first time ever that shareholders in Japan rejected a merger plan approved by the boards of the two companies.
The Tokyo Kotestu case was followed within weeks by a second successful shareholder-driven resistance to a merger. In December 2006, Hoya announced a merger with Pentax. Shareholders of Pentax felt the swap ratio undervalued the company and pressurised the board to oppose the merger. In the aftermath the Pentax president resigned in April and at the time Pentax announced ôthe merger shall be abandoned at this point in time due to conditions within the company as well as conditions outside the company, including shareholdersö.
The wave is being helped by organisations such as Securities Investors Association (ôSIASö), Webb-site and ISS, who make it their job to inform retail shareholders when their rights are abused. Company management can no longer bury potentially contentious motions in the fine print of shareholder resolutions, confident that they will never be read û these organizations ensure every proposed corporate action is rigorously examined.
In Singapore, SIAS was founded in 1999 and today terms itself ôthe largest organized investor lobby group in Asia with 66,000 retail investors as membersö. It promotes investor education, corporate transparency/governance and is a watchdog for investor rights.
Via Webb-site.com, Webb publicises cases of shareholder abuse. He also won election to the Hong Kong Exchange in 2003 and 2006, using his position to push for accountability from companies listed on the exchange.
ôIn Hong Kong retail investors are generally out of the loop on shareholder meetings as there is no obligation on their custodian (banks and brokers) to tell their clients about shareholder meetings and seek voting instructions. So the votes mainly come from institutional investors, including hedge funds,ö is Webb's comment. He seeks to change that û both through his own actions and lobbying for better legislation.
Washington DC-headquartered ISS was founded in 1985 to provide corporate governance solutions that enhance the interaction between shareholders and companies. Since this decade, it has an active presence in Asia. Tokyo-based Goldstein from ISS is optimistic that retail investors are growing cognisant of their rights commenting: ôhedge funds and other investment funds may have led much of the activism but individual investors have started sponsoring shareholder proposalsö.
These efforts have been helped by a new era of information dissemination for example Gavin Anderson led the communications strategy for Dubai-based Sovereign Asset Management in its bid to reform SK Corporation and also advised JapanÆs Ichigo on the Tokyo Kotetsu case.
Gavin AndersonÆs Richard Barton says: ôAmong the drivers for change is the huge speed with which information now flows. Traditional corporate opaqueness needs to confront the fact that institutional and retail investors now have far better access to information and to forums to promote grievances.ö
Following a spate of listing from countries such as China, with very different or non-existent traditions of corporate governance, shareholders often have legitimate questions and demands of company management.
Webb-siteÆs Webb cites ôChinaÆs CNOOCÆs proposal to deposit money with its parentÆs finance vehicle which was defeatedö as an example. CNOOC sought minority shareholder approval for the continuation of 'deposits' for three years to CNOOC Finance, an unlisted vehicle majority-owned by CNOOC's state-owned parent, China National Offshore Oil Corporation. Webb asked whether this type of lending was in the interest of maximising returns for the lending company and successfully mobilised 52% of CNOOC shareholders to vote down the proposal.
Consensus is emerging that company management acts in a fiduciary capacity and is answerable to all stakeholders. Webb-siteÆs Webb goes one step further saying: ôinvestors are the owners of the company, not financing patsiesö. That is, company management becomes so concerned with conditions attached to financing and loan covenants that they sometimes overlook the interests of the small shareholder.
Because funds are focused on returns, they are û almost ironically û uninterested in corporate governance. Thus, Korean tobacco major KT&G became a target for Carl Icahn and Warren Lichtenstein in 2006 because it was under-utilising its assets. MilbankÆs Kim says the KT&G case : ôdemonstrated that it is possible to have good corporate governance but still not deliver an appropriate return on assets.ö
Goldstein adds that retail shareholders in many instances ôare not necessarily activists themselves but may be willing to support other shareholders who are û particularly if the activism focuses on economic issues.ö As institutional shareholders use media to publicise the reasons for their activism, they can garner support from smaller shareholders who may either not have realised the issues or may not have had the wherewithal to be change agents themselves. Wide dispersions of shareholdings in a number of small folios in the region is the norm. These small shareholders are realising the potential they have to effect change, collectively.
ôInstitutions can only have an impact by reacting to proposals which require minority shareholder approval,ö suggests Webb-siteÆs Webb, commenting on the structure of markets in Asia where many companies still have a controlling shareholder who owns a majority stake.
In most capital markets regulators have placed restrictions on significant steps management of listed companies can take, such as disposal of core assets or a merger, by stipulating that minority shareholder assent must be received by an affirmative vote. Unfortunately, a large number (in volume, not value) of shareholders see themselves as simply a parking ground for the shares they buy. They are interested in the return on investment (ROI) they can earn through their holdings and donÆt necessarily think about their role in achieving that ROI.
This is where organisations like ISS and Webb-site play a role. But even with their help, the onus of ensuring minority shareholder interests are not compromised often falls on institutional shareholders who hold large blocks of shares.
To effectively discharge this role, institutional shareholders have to act independently of company management, which is not always the case. For example, commenting on the situation in Korea, Goldstein from ISS observes ôdomestic institutional investors donÆt play a major role in shareholder activism as they still tend to be quite management friendly.ö
What makes Korea different, from say Japan, is that foreigners own a large percentage of shares in Korea for example foreigners own majorities of companies such as Samsung Electronics and POSCO. Foreign investors donÆt have the same chummy feeling about local management, although it is only recently they have been willing to confront management.
The Sovereign situation was probably the first such case. SK Corporation tried to use regulators and local media to queer the pitch but Sovereign persisted and MilbankÆs Kim, who advised Sovereign, remarks: ôIcahn would almost certainly not have been attracted to Korea had not Sovereign, which is a private investment vehicle but not a hedge fund, walked away from its two-year assault on SK in 2005, with a five-fold return on its $142 million investment.ö
Goldstein adds: ôIt is a mistake to assume that foreign investors will always vote as a bloc but an activist who can sway a majority of those foreign owners has a reasonable chance of succeeding.ö In the KT&G case, it was after Icahn banded together with Lichtenstein, that the combine secured a board seat in March 2006.
Ultimately, the Icahn-Lichtenstein bid was unsuccessful in wresting control of KT&G, but did result in the company restructuring itself through exiting the convenience stores business and non-core assets. KT&G also returned cash to shareholders.
MilbankÆs Kim suggests the rise in activist shareholders is ônot necessarily because they are true believers in doing good as in improving corporate governance as a value in itself.ö
While this is true, it is equally true that it is not only the activists who benefit from their actions, but shareholders across the board, big and small.
Further, companies have a choice. If they donÆt approach equity capital markets for funding, they donÆt have to comply with the high standards of corporate governance which regulators have prescribed to ensure the investing public are not short changed. Asian companies are realising this and the emergence of both an active pool of financial sponsors and liquid debt markets are providing the necessary capital for them to delist. A spate of private equity led minority buyouts in the region are driven by the need to restructure the business of the target û and the ease of affecting that restructuring without minority shareholders.
Gavin AndersonÆs Barton sums up: ôThe increased focus of global investors û especially activists û on Asian corporates will force companies onto a new playing field; either they respect the rights attached to the owners of their capital û or they may find that the market forces change on them in a very public manner.ö
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